Asset allocation, the proportion of stocks, bonds and cash in a portfolio, is one of those topics that financial advisors think about constantly. Because we have clients with such a variety of needs and changing financial scenarios, we are always working with someone to help them find the appropriate investment allocation for their personal situation. For the typical investor however, it shouldn’t be so hard. Once you’ve chosen the appropriate allocation, you should stick with it as long as your financial or life circumstances haven’t changed much. This type of “set it and forget it” mentality is the mark of a disciplined investor.
But what about the asset allocation for a college fund? For a newborn child you only have 18 years before you have to pay out a significant portion of the fund, which you will then deplete over 4 years. If you start saving later, the time frame is even shorter. This is very different from a retiree who will often have a longer time frame than 18 years. Also, for a retiree, typically the intention is to spend around 4 to 5% of the retirement portfolio value every year, so that the retirement funds continue to grow over time. This isn’t the case with a college fund. It can be both long-term (18 years to grow) and short-term (all paid out over 4 years) at the same time. It makes the asset allocation decision a conundrum. Now throw in the fact that somehow children grow up faster than you can possibly imagine and each year the time until payout grows exponentially closer, requiring more frequent allocation tinkering.
If you are able to save when your children are babies, the allocation decision is fairly easy. With an above-average risk tolerance you might choose 100% equities. Once kids are in their teens though, you could switch to a more conservative allocation with a mix of stocks and bonds. As they approach their final year of high school, you could move to all fixed income. There is no easy solution here, and often it depends on the parents outside resources. If the parent is entirely dependent upon the college funds to pay for college, the fund should be more conservative as they approach age 18. The give up is potentially less money for college if the stock market is doing well during these years.
If you have multiple children with 529 plans for each, and outside resources in addition to this, you may choose to stay with a higher equity allocation. If the stock market doesn’t perform well during the college years, the parent could choose to pay some expenses out of pocket and then roll any excess 529 funds to younger siblings.
Regardless of the allocation you choose, you are taking a risk. If you’re too conservative you may not have enough money to pay for college. Conversely, if you’re too aggressive, you stand the chance of losing money you’ve saved all along just at the time that you need to withdraw it. My advice is to discuss the allocation with your financial advisor. Your risk tolerance will be the main driver in this decision. Other important factors will be outside resources for paying for college, as well as your family’s unique circumstances.
Harli L. Palme, CFA, CFP®